Nikola inc. decides to raise $1,000,000 for a new investment project. From shareholders perspective, Nikola stock can be worth $600 or $400 with equal probability. The market price is thus equal to the expected price $500. The firm can raise the money with equity or debt.

a. If the firm announces it will raise the money with equity, what is the stock price?

b. If the firms true stock price is $600, and the firm needs to pay an interest rate of r on the debt, even though the firm believes 4% is a fair rate. Calculate r at which the firm is indifferent to using equity or debt.

For question c. and d., assume if the firm decides to use debt, it needs to pay an interest rate of 5%, even though 4% is a fair rate.

c. If the firms true stock price is $600, will the firm use stock or debt? First answer the question, then show the calculation.

d. If the firms true stock price is $400, will the firm use stock or debt? First answer the question, then explain.